An Estate Planning Solution for Parents Whose Children Have Student Loans

There has been a significant increase in student loan debt as well as default rates by borrowers leading to an increased risk that the estate a borrower’s parent intends to pass to their child could instead end up in the hands of a student loan lender or collection agency.  If your child has significant student loan debt, difficulty repaying their student loan debt, or if you just want to minimize the chance your estate could end up in the wrong pocket, then you should continue reading below to understand how you can protect your child and your assets from these creditors.

Understanding the Scope of the Student Loan Problem

There is over $1.45 TRILLION dollars in student loan debt outstanding in the United States today.  That is over 600 million more than outstanding credit card debt.  Outstanding student loan debt has increased over 170% since 2006!  Even more alarming – according to the New York Federal Reserve, borrowers are making less progress in paying down those student loans even as the amount of student loans issued continues to increase.  Over 42 million Americans now have student loan debt.

This is a recipe for disaster.  Delinquency rates on student loans are in excess of 11% (meaning loans more than 90 days past due).  Default rates are much higher.  The New York Federal Reserve has done significant research over the past year on default rates and some of the results are stunning.  According to the New York Federal Reserve, over 35% of students attending for-profit private colleges have defaulted on their student loans by the age of 33.

Some parents might have children that attended community college and think that defaulting on student loans is a problem that is unique to 4 year universities or private for-profit universities.  It’s true, borrowers attending private for-profit colleges have historically seen some of the highest default rates.  However,  borrowers attending public 2 year colleges (think community colleges) have seen the greatest statistical increase in default rates with borrowers defaulting at rates almost as high as private for-profit colleges.

The impact on the lives of these borrowers is dramatic.  Student loans are one of the few debts that can NOT be discharged in bankruptcy.  This leaves student loan borrowers with little hope of escaping the debt without paying it.  The burden of repaying these loans means that student loan borrowers are less likely to own homes and save for retirement.

Private lenders aggressively pursue collection of delinquent borrowers through collection agencies, law suits, and garnishments (in some states).  If students default on federal loans, then the government has even greater powers to collect on the loans including garnishing the borrower’s social security payments which impacts the borrower’s ability to provide for his or her self during retirement.  When borrowers default, they incur penalties and interest that cause the outstanding debt amount to increase significantly over time.

How Your Child’s Student Loans Affect Your Estate

If you have a child with student loan debt, have you talked to them about the status of their loans?  Are they able to repay them? Have they defaulted on their loans?  Would they be honest in telling you about their troubles if they had them?  What if they run into financial trouble after you have already passed away?

These are difficult conversations that parents often do not have with their children.  But they need to.

Remember – these loans are not dischargeable in bankruptcy and lenders are quite aggressive in collecting these debts.

This means that if you leave any assets to your child, and that child defaults on a student loan, then those assets become subject to a lender’s collection efforts.  Your child may not inherit anything until 10, 15 , or even 20 + years after he or she defaulted on their student loans.  But those debts did not go away.  They just kept growing and accruing penalties, interest, and likely court costs as well as attorneys fees.

A collection agency cannot attach, execute, or garnish the assets of your child.  Collection agencies operate through coercion and guilt.  But the original creditor, or in some cases a collection agency that purchased the loans, can go to court and secure a judgment.  Any attorneys fees and court costs the creditor incurs in trying to collect the outstanding loan balance are added to the judgment and accrue interest as well.

At this point, the creditor has much more significant collection powers including the power to execute a judgment by confiscating assets or potential garnishing bank accounts.  Judgment creditors may, in certain circumstances, have a receiver appointed pursuant to a turnover order to help collect on that judgment.

The net result is this – that estate you worked so hard to grow and pass on to your child could be wiped out by your child’s student loan debt.

Using A Trust to Protect Your Child and Your Assets

What if I told you that there is a solution in Texas? That there is a way to allow your child the benefit of your estate without risking that the assets may be taken by a creditor.  Well, there is.  It’s through the use of a trust.  Trusts are not just an estate planning device for the super wealthy.  Trusts can be used to make sure that your estate is passed on and used according to your wishes and not the wishes of a creditor.

The law is clear – you have the right to choose who receives your estate.  More importantly, when you leave your assets in trust, you have the right to choose how, when, and for what purposes those assets may be used.  You have the right to choose who will manage those assets.  You have the right to prohibit their use to pay off the debts of a beneficiary.  When that trust is properly formed and managed – your child’s creditors cannot touch the assets but your child can still benefit from use of those assets.

Establishing the trust and protecting its assets from a beneficiary’s (your child’s) creditors is highly technical.  But it is perfectly legal.  There are restrictions on who can put assets into the trust and rules for when and how assets are distributed.  The language in the trust agreement is critical.

With a properly drafted and managed trust, your assets are protected for your child’s benefit.  You child and your grandchildren can enjoy the use of the trust assets for such things as healthcare, health insurance, dental and eye care, housing, paying the bills, property taxes, paying educational expenses, as well as general maintenance and support.  And your child’s creditors cannot take those assets.  You can make sure your estate goes to supporting your child and his or her family instead of paying off a debt to a creditor.

If you would like more information about whether a trust is appropriate for your situation, then please complete the contact form below and someone form the Firm will contact you shortly.

Estate Planning Tips for Individuals and Families Building Wealth for the First Time

With new wealth comes new priorities, new problems and a new importance to estate planning issues.  Below are eleven estate planning tips for individuals and families building wealth for the first time.

1. Estate Planning Is Not All About Tax Planning.

A common misbelief is that estate planning is only for the very wealthy and that an estate plan is only created to reduce estate taxes.  This is not true.  Tax planning is merely one piece of the estate planning process and the estate tax exemption is so high that it is not a concern for many estates.

The goals of the estate planning process are the preservation of wealth, providing for the care of yourself, providing for the care of your family, ensuring your assets are distributed as you instruct, and ensuring that decisions made when you are incapacitated or near the end of your life are made according to your wishes.

These goals are true regardless of the size of the estate but certain goals (such as preserving wealth) increase in importance as the value of the estate increases.

2. Take Care of Your Kids First.

Every parent, regardless of the size of their estate, should have a will for one simple reason: to appoint a guardian for their children should both parents pass away.   The birth of a child alone should cause new parents to create an estate plan.

When your family begins accumulating wealth, your planning for the care of your children should expand as well.  This might include the use of contingent trusts to provide for the management of any assets that might pass to your children when they are minors or young adults.

You should also make sure that you provide a mechanism to finance the care of your minor children.  Many people appoint a guardian but fail to recognize that raising your child will impose a significant financial burden on that guardian.  Providing a method of easing that financial burden is important to ensuring that your children live a life full of opportunity should you pass before they are grown.

As your children grow you should make sure that you include them in your estate planning.  I’ll discuss that more below in tip #8.

3. Evaluate Whom You Choose As Executor Carefully.

As your wealth increases, so will the complexity of your estate.  No longer just a bank account and a house, your assets may include various investment accounts, retirement accounts, and businesses.  This means that you must honestly evaluate whether the individual you selected to serve as executor under your will is truly capable of performing that task competently.  This means the common default appointment of your spouse as executor may be inappropriate.

Be honest about the complexity of your estate.  Be honest about the abilities of anyone you are considering for the role of executor.  Make sure you understand the duties, responsibilities, and potential liabilities of anyone you appoint as executor to oversee the administration of your estate.  You created this wealth to provide for the safety and security of your family, not to add to their stress or expose them to liability trying to administer an estate they are not capable of managing.

For many estates or estates with unique income producing property, it may be appropriate to consider a corporate executor with relevant expertise.

4. Consider Incorporating an Asset Protection Strategy Based On Your Risk.

Wealth = Risk.  Its a simple fact of life that those who have wealth are often targets for those who do not.  When an accident happens, the victims will look to those with the deepest pockets to make them whole.  Insurance companies will look for reasons to avoid paying on a policy.

This means that you too must look at asset protection strategies to protect your new wealth in a worst case scenario.  There is nothing morally, ethically, or legally wrong with asset protection planning – but it must be done in advance.  This is especially important for business owners active in the management and operation of their business.

You worked hard to grow your wealth and you have every right to protect it.  You do not want years or decades of hard work to disappear in an instant because of one simple mistake.  The use of trusts or various combinations of business entities can help make sure that you and your family do not lose everything in an instant.

5. Consider Splitting Your Savings Between Pre and Post-Tax Accounts.

It is important to distinguish between wealth and income.  Wealth is money or assets you already own.  Income is new assets or money you acquire.  You can be quite wealthy yet not be in the top income tax bracket or at the top of your current income tax bracket.

In these situations, you might consider converting pre-tax retirement accounts (such as a traditional IRA) into a post-tax account (such as a Roth IRA).  These conversions can be staged over time to avoid pushing you into higher income tax brackets as you will increase your tax bill for the years you make any conversion.  The idea is to pay less tax now then you would pay in the future.

Converting your accounts to post-tax accounts allows you to hedge against two risks.  The first is the risk that your income will continue to increase as you age, pushing your retirement distributions into a higher tax bracket than you would pay now.  The second risk is that Congress will increase income taxes in the future.  Remember, current income taxes are much lower than they were historically and the Federal government’s debt is increasing at rapid rates.  Higher income taxes in the future are a near certainty.

6. Consider A Philanthropic Trust.

For those who have a charitable inclination, you should consider forming an irrevocable charitable trust.  The trust allows an instant deduction for your contributions while allowing you to grow and distribute the trust funds to various charitable endeavors over time.  This provides a short-term financial benefit and a long-term philanthropic benefit.  A charitable trust could also be created in such a way as to allow its management to pass on to your children allowing your giving to have a positive impact on society and your family for generations.

7. Consider Transferring Ownership of Your Life Insurance Policy(ies).

This is something that is easy to overlook.  Life insurance proceeds are not considered taxable income so most people do not consider them in their estate plan.  However, they are considered part of the estate for estate tax purposes which means an estate that is below the estate tax exemption amount could find itself subject to the estate tax because of life insurance proceeds.

Worse yet, those life insurance proceeds may be a sizeable amount that passes outside of probate leaving only the other estate assets to satisfy the estate tax.  This can create unfair and unintended consequences for your asset distribution plan by burdening some beneficiaries with the estate tax while others are not.

Life insurance trusts are available to avoid this issue by transferring ownership of the policy prior to your death to avoid its inclusion in your estate.

8. Make Sure to Involve Your Children and Beneficiaries in the Planning Process.

As your children and beneficiaries get older, it is important that you include them in your estate planning process for a number of reasons.  They need to understand your plan and your intentions.  This goes a long way in avoiding any misunderstandings or disputes after your passing.

There are also certain benefits that you can take advantage of by involving them early.  For example, if you setup a trust for their benefit and your children are in a lower income tax bracket, then those trust funds could be used to help them during your life and obtain some tax savings.  Also, it may be to your advantage to take advantage of the annual gift tax exclusions to begin transferring some of your wealth to them prior to your passing.

For business owners, it is important to bring your children into the business to familiarize them with your succession plan as well as your advisors and employees if you intend to have them take control of the business.

9. Make a Plan For Your Business.

Many people grow through wealth through business ownership.  If that is the case with you, then you must prepare a business succession plan as part of your estate plan.  The details of a business succession plan are beyond the scope of this article but it should address a number of issues including transferring ownership on your death, management if you become incapacitated, as well as the distribution of proceeds if you intend for the business to be sold.

10. Don’t Forget to Take a Holistic View.

It is important to make sure that someone takes  a bird’s eye view of your estate plan.  It is not uncommon for many professionals to handle various parts of your estate planning, such as an investment advisor handling beneficiary designations on your investment accounts, a banker handling designations on your bank accounts, an attorney drafting your estate planning documents, or a CPA or employer representative handling other matters.

Your estate plan should be comprehensive and integrated.  This means you must make sure that each part of your estate plan complements the others and designates beneficiaries in such a way that your estate plan as a whole is implemented according to your wishes.

11. And Don’t Forget the Other Documents.

Your will is just your starting point as there are important ancillary documents you should execute.  These include a Power of Attorney, to appoint someone to act on your behalf in business, financial, real estate, and money management.  A Medical Power of Attorney, to appoint someone to make decisions regarding your medical care should you be unable to do so.  An Advance Directive, to make your wishes regarding end of life care known.  And a Declaration of Guardian, to designate whom you would or would not want appointed to see to your physical well being in the event you become incapacitated.

Key Probate Terms to Understand When talking to Your Attorney

Law Dictionary

I put together this list of terms with easy to understand definitions (I hope) and examples for my probate clients so that they could familiarize themselves with many of the probate terms they will hear during the probate process.  Then I thought, why not share it with other folks trying to understand how the probate process works?

Note: It is possible that some terms, such as “child” could actually have a different definition if the deceased defined the term in his or her will.

Administration or Administration of the Estate.  This refers to the probate process as a whole regardless of whether the deceased passed away with or without a will.  It includes both dependent and independent administrations.  In general, administration of the estate involves the following steps:  opening the administration and appointing a personal representative; collecting the assets of the estate; paying any estate taxes; identifying, classifying, and settling claims against the estate; distributing the estate assets to appropriate heirs or devisees; and then closing the estate.

Administrator. An “administrator” is the individual appointed by a probate court to administer the estate of an individual who died without a will.

Child. The term “child” includes natural born children as well as adopted children.  However, it generally does not include a child of a deceased male if that male was not the child’s presumed father.  A presumption of fatherhood is established by law with specific time requirements around the birth of the child and a marriage between the presumed father and mother of the child.

Claims.  The term “claims” includes a number of items that may arise before or after the deceased individual’s death.  For example, liabilities of the deceased, taxes, and estate taxes are claims.  So are the expenses incurred in the administration of the deceased’s estate.

Decedent.  “Decedent” is the legal term for the person who passed away.

Dependent Administration.  A “dependent administration” is an administration conducted under close court supervision.  Dependent administrations are usually more expensive because the personal representative’s authority to take action is limited and usually requires prior approval from the probate court.

Devise.  “Devise” refers to a phrase in a will setting forth the distribution of property.

Devisee. “Devisee” refers to one who receives a devise under a will.

Estate Tax Returns.  “Estate Tax Returns” is often used loosely to refer to a number of tax reports that must or may be filed during the probate process.   There are two types of tax returns – income tax returns and actual estate tax returns.  For example, the last income tax return for the deceased for the year in which he or she died must be filed by the personal representative.   The personal representative will also be required to file an  income tax return for the estate itself.  Certain estates may be required to file an estate tax return because the size of the estate necessitates payment of estate taxes.   In certain cases, the personal representative may choose to file an estate tax return even though the size of the estate does not require payment of estate taxes in order to support the “porting” of the deceased’s estate tax exemption to his or her surviving spouse.   Some states may also require an estate tax return if the deceased owned property in a state that required estate tax returns.

Executor. The “executor” is the person designated by a will to administer the estate of an individual who died with a will.  The executor’s appointment must be made by the probate court.

Exempt Property.  “Exempt Property” is certain property defined by law to automatically vest in specific individuals in priority to any other laws of inheritance or devises set forth in a will.  Examples include a homestead exemption for a surviving spouse, minor children or adult unmarried children residing with the family as well as exempt personal property set forth in the property code.

Exempt Property Allowance.  When the deceased’s estate does not contain a homestead or exempt personal property, the surviving spouse and children may receive an allowance in lieu of the exempt property.

Family Allowance.  If a surviving spouse (with or without children) does not possess sufficient property to provide for their own support, then they are entitled to a “family allowance” from the estate for a period of one year from the date of the deceased’s death to be paid as a priority out of the estate’s assets.

Heir. An “heir” is someone who is entitled to receive a deceased individual’s property when that individual dies without a will.

Holographic Will.  A “holographic will” is a document setting forth the disposition of a deceased individual’s estate that is written entirely in the deceased individual’s handwriting.

Independent Administration.  An “independent administration” is an administration conducted with minimal court supervision of the personal representative.  There are specific requirements for an estate to be administered independent of the court but usually results in a less costly probate process because the personal representative may take most actions without prior approval from the probate court.

Intestate. “Intestate” is often used in the phrase, “died intestate.”  This simply means that the individual passed away without a will.

Legacy.  A “legacy” is a gift or devise of property made in a will.

Legatee.  A “legatee” is a person entitled to receive a legacy under a will.

Letters of Administration.  This is the document issued by the probate court to the administrator that the administrator provides to third parties in order to show his or her authority to act as the court appointed personal representative of the deceased individual’s estate.  These letters serve as proof of the administrator’s authority to take possession of the deceased individual’s property as personal representative of the estate.

Letters Testamentary.  This is the document issued by the probate court to the executor that the executor provides to third parties in order to show his or her authority to act as the court appointed personal representative of the deceased individual’s estate.  These letters serve as proof of the executor’s authority to take possession of the deceased individual’s property as personal representative of the estate.

Non-probate Assets.  “Non-probate assets” refers to property that does not pass or transfer title through the probate process.  Most property can, through proper estate planning, be made into a non-probate asset.  Examples of non-probate assets include the following: bank accounts with payable on death designations, retirement accounts with beneficiary designations, and real property if title is held with a right of survivorship.  Beginning in 2016, Texas enacted a law that allows title to automobiles to also be held with a right of survivorship that allows title to the automobile to transfer outside of the probate process.

Personal Property.  “Personal property” refers to every type of tangible or intangible property that is not real estate.  This could include money, clothing, cars, promissory notes, a lease agreement, or anything else that is movable and has value.

Personal Representative.  “Personal Representative” is a term used to refer to both executors and administrators.  In the case of an estate where the deceased had a will, the term refers to the executor.  In the case of an estate where the deceased did not have a will, the term refers to the administrator.

Probate Assets.  “Probate assets” refers to property that must pass through the probate process in order to transfer title from the deceased individual to an heir or devisee.

Real Property.  “Real property” means property that is real estate or land.

Self-Proved Affidavit.  A “self-proved affidavit” is an affidavit executed by the deceased and two witnesses that is used to prove the validity of the will when admitting the deceased individual’s will to probate.

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